Establishing a functioning marketplace for bad loans will prove a real test for Italy

It is hard to beat Monte dei Paschi’s stock price as a window into what troubles investors about Italy’s banking sector. In early July, the shares of the world’s oldest bank collapsed more than 30 per cent in two days after the European Central Bank ordered the lender to cut €10bn of loans that had soured.While Italian prime minister Matteo Renzi is pushing Brussels for permission to inject more capital into a banking sector saddled with €360bn of loans which are unlikely to be repaid in full, the long-term benefits of new funds will be limited unless Italy can establish a functioning marketplace for such debt. Just €19bn of bad loans were sold last year, according to PwC.

So far, efforts to tackle the problem include Atlante, a private fund designed to backstop the sector, as well as a plan to securitise the loans with a government guarantee. These measures have failed to restore confidence, and investors and experts warn some of the hurdles Rome faces in tackling NPLs are higher than in other peripheral European countries racked by bad debts.

“The steps from the Italian government are going in the right direction, but this doesn’t stop here,” says Filippo Alloatti, an analyst at Hermes. “It’s a problem of an underperforming economy, a problem of a system that is still too bank-centric. The question is: are the Italian banks the most appropriate owner of this type of asset?”

Of the €360bn of exposures, €200bn are loans to creditors already deemed insolvent and of these €85bn are not already written down on banks’ books.

One pressing issue for buyers of loans is the nature of the collateral backing them. In Spain, much of banks’ bad debts were linked to home loans.

“At least in Spain and Ireland there was one asset class, residential real estate,” says Eoin Mullany, an analyst at Berenberg. “Generally there was a clearing price and it was quite liquid. In Italy, over 80 per cent of NPLs are non financial corporates. It’s very difficult to get a feel of what the value for that collateral is.”

The Bank of Italy said in April that half of the country’s gross bad loans — around €160bn — were covered by collateral offered up by borrowers. “With respect to bad debts, the value of the collateral exceeds the book value of the loans”, the central bank said in a report on financial stability.

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